The energy transition would need a major change in the mentality of stock market investors to succeed. Investors’ focus on relatively fast returns and immediate financial performance right now makes them reluctant to invest in transition companies. And this could become the death knell of that transition.
“Public markets are probably the cheapest cost of capital,” KKR partner and co-head of climate, Emmanuel Lagarrique, told Bloomberg recently. “But at the same time, they have volatility and very short memories, so it’s very difficult to have a long-term, thoughtful strategy for very large and consequential corporate transformations.”
Yet in another recent report, the same publication cited Wall Street banks as pushing back against pressure to invest more in the energy transition—with the argument that they would basically be happy to do it, as long as it makes them money. Perhaps Wall Street banks suffer from the same shortsightedness as most other public companies. Or perhaps they have a good reason to focus on returns.
Earlier this year, several Big Oil supermajors, notably BP and Shell, signaled a pullback on their transition investments. Those were not making the money they were expected to be making, and the companies were shrinking their exposure to unprofitable projects.
Governments are pulling back on transition financing as well, as their coffers begin to empty. The UK is introducing a road tax for EVs, for instance, while Germany is axing subsidies for wind and solar generators during times of negative electricity prices. These times are becoming increasingly frequent because of the wind and solar capacity expansion, whose output depends on the weather. This leads to surplus generation during periods of low demand.
So, if governments are no longer capable of funding the transition, why should public companies do it? Per KKR’s Lagarrique, “It’s very difficult for the CEO of a company to go to their shareholders and say I’m going to invest 3 billion in a new asset that’s going to radically change our carbon footprint and create new growth, but the cash flows are coming in five or seven years.”
The problem that most companies have with transition investment, however, is not that “the cash flows are coming in five or seven years.” It is that these cash flows may never materialize—because of things like negative electricity prices and exorbitant EV price tags, or green hydrogen costs.
Australian billionaire Andrew Forrest, a mining vet and vocal green hydrogen proponent, recently laid off 700 people and dropped a plan to turn his iron ore company Fortescue Metals into a green hydrogen major by 2030. Per a Financial Times report, Forrest had realized that his ambition to pump out 15 million tons of green hydrogen by 2030 was unrealistic.
There is also the issue of interest rates. Until a couple of years ago, investment flowed into what some call transition technology in part thanks to low interest rates that made things like wind and solar cheap to build. But then things changed and rates went up as central banks struggled to rein in post-lockdown inflation. Transition investment costs swelled substantially. And returns became a lot more uncertain.
Earlier this year, Wood MacKenzie forecast that interest rates are set to remain higher than they were in the past for the net twenty years or so, which would make life difficult for transition companies. That is because they are more reliant on debt financing than oil and gas companies, and because they are reliant on subsidies—rather than profits from their operations.
This is precisely why Wall Street is pushing back at activist pressure. Wall Street—and any other investment company, really—is in the business of making money for its clients and/or shareholders. Transition companies are not exactly making money now that conditions are not as perfect for them as they were a couple of years ago. Yet this change in environment was only to be expected, just like negative electricity prices in Europe.
Wind and solar were touted as cheaper than any other form of energy. When they proved they were, indeed, cheaper, with overproduction leading to sub-zero prices, it turned out that cheap does not always mean profitable and this must have made potential investors in these industries wary. Because the question is not when the returns would start flowing in. The question is whether they would start flowing in at all.
For now, the answer remains rather elusive, which is why investors with deep pockets are taking a guarded stance on the whole transition push. The number of reality checks, meanwhile, is rising: from Forrest’s decision to postpone his grand green hydrogen plans to the slew of bankruptcies in EVs and a similar slew of bankruptcies in solar, signs are multiplying that the transition is going to be a lot more challenging than originally advertised.
By Irina Slav for Oilprice.com
Lead Image (Credit: Oil Price)
